UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999.
------------------
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---------- ---------
COMMISSION FILE NUMBER 0 - 26728
TALK.COM INC.
--------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE
--------------------------------------------------------------
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)
23-2827736
--------------------------------------------------------------
(I.R.S. EMPLOYER IDENTIFICATION NO.)
12020 SUNRISE VALLEY DRIVE, RESTON, VIRGINIA 20190
--------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES - ZIP CODE)
703-391-7500
--------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
--------------------------------------------------------------
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT.)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT
WAS REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND
REPORTS REQUIRED TO BE FILED BY SECTION 13, OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN CONFIRMED
BY A COURT
YES NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS: INDICATE THE NUMBER OF SHARES OUTSTANDING
OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE
DATE.
AS OF NOVEMBER 5, 1999, 64,670,445 SHARES OF COMMON STOCK WERE ISSUED AND
OUTSTANDING.
<PAGE>
TALK.COM INC.
FORM 10-Q
SEPTEMBER 30, 1999
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1999
and December 31, 1998
Consolidated Statements of Operations for the three and nine
months ended September 30, 1999 and 1998
Consolidated Statement of Stockholders' Equity (Deficit) for
the nine months ended September 30, 1999
Consolidated Statements of Cash Flows for the nine
months ended September 30, 1999 and 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
PART II - OTHER INFORMATION
Signatures
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
(UNAUDITED) DECEMBER 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
CURRENT:
Cash and cash equivalents $ 43,552 $ 3,063
Marketable securities -- 89,649
Accounts receivable, trade, net of allowance for uncollectible accounts
of $3,729 and $1,669, respectively 57,299 46,587
Advances to partitions and notes receivable 1,997 1,870
Prepaid expenses and other current assets 10,497 8,600
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 113,345 149,769
Property and equipment, net 56,987 56,703
Intangibles, net 1,089 1,150
Other assets 3,843 64,938
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 175,264 $ 272,560
====================================================================================================================================
LIABILITIES, CONTINGENCIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT:
Margin account indebtedness $ -- $ 49,621
Accounts payable and accrued expenses:
Trade and other 35,559 64,794
Partitions 5,475 4,380
Other 21,770 17,913
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 62,804 136,708
Convertible debt 84,985 242,387
Deferred revenue 22,850 28,400
Other liabilities -- 1,850
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 170,639 409,345
- ------------------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
Contingent redemption value of common stock 25,115 --
- ------------------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares
outstanding -- --
Common stock - $.01 par value, 100,000,000 shares authorized; 66,934,635
issued 669 669
Additional paid-in capital 205,372 265,325
Accumulated deficit (155,981) (218,229)
Treasury stock, at cost (70,550) (184,550)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (20,490) (136,785)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES, CONTINGENCIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 175,264 $ 272,560
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------------- -----------------------------
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SALES $ 140,027 $ 122,525 $ 367,738 $ 324,769
COST OF SALES 85,476 99,789 233,592 269,427
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 54,551 22,736 134,146 55,342
GENERAL AND ADMINISTRATIVE EXPENSES 11,274 10,822 30,461 30,645
PROMOTIONAL, MARKETING AND ADVERTISING
EXPENSES 27,698 107,653 63,490 192,592
SIGNIFICANT OTHER CHARGES (INCOME) -- 308 (2,718) 21,903
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) 15,579 (96,047) 42,913 (189,798)
INVESTMENT AND OTHER INCOME (EXPENSE), NET (933) 3,751 (1,895) (59)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES 14,646 (92,296) 41,018 (189,857)
PROVISION FOR INCOME TAXES -- -- -- 40,388
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE EXTRAORDINARY GAIN 14,646 (92,296) 41,018 (230,245)
EXTRAORDINARY GAIN 2,233 50,562 21,230 50,562
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 16,879 $ (41,734) $ 62,248 $(179,683)
====================================================================================================================================
BASIC EPS:
INCOME (LOSS) BEFORE EXTRAORDINARY GAIN $ 0.24 $ (1.58) $ 0.68 $ (3.69)
EXTRAORDINARY GAIN 0.04 0.87 0.35 0.81
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 0.28 $ (0.71) $ 1.03 $ (2.88)
====================================================================================================================================
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC 61,343 58,376 60,233 62,317
====================================================================================================================================
DILUTED EPS:
INCOME (LOSS) BEFORE EXTRAORDINARY GAIN $ 0.23 $ (1.58) $ 0.65 $ (3.69)
EXTRAORDINARY GAIN 0.04 0.87 0.34 0.81
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 0.27 $ (0.71) $ 0.99 $ (2.88)
====================================================================================================================================
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES
OUTSTANDING - DILUTED 63,480 58,376 63,093 62,317
====================================================================================================================================
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK
----------------------- PAID-IN ACCUMULATED ------------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT TOTAL
-------- -------- ---------- ----------- --------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 66,935 $669 $265,325 $(218,229) (12,949) $(184,550) $(136,785)
Net income -- -- -- 62,248 -- -- 62,248
AOL investment -- -- (3,730) -- 4,121 58,730 55,000
Exercise of common stock
options -- -- (29,780) -- 3,863 54,770 24,990
Acquisition of treasury
stock -- -- -- -- (639) (7,686) (7,686)
Issuance of common stock
for convertible debt -- -- (1,328) -- 575 8,186 6,858
Contingent redemption value
of common stock -- -- (25,115) -- -- -- (25,115)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1999 66,935 $669 $205,372 $(155,981) (5,029) $(70,550) $ (20,490)
====================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------
1999 1998
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $62,248 $(179,683)
Adjustment to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Provision for bad debts 2,181 6,130
Depreciation and amortization 4,449 4,145
Vested AOL warrants and amortization of prepaid AOL marketing costs -- 71,665
Purchased research and development -- 21,034
Deferred revenue (5,550) (5,550)
Extraordinary gain (21,230) (50,562)
Compensation charges -- 1,500
Valuation allowance for deferred tax assets -- 40,388
(Increase) decrease in:
Accounts receivable, trade (12,772) (14,207)
Advances to partitions and notes receivable (127) 20,794
Prepaid expenses and other current assets (1,896) (4,741)
Other assets 4,084 (67,578)
Increase (decrease) in:
Accounts and partition payables and accrued expenses (24,405) 35,485
Other liabilities (1,850) (1,592)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 5,132 (122,772)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (4,671) (8,369)
Sale (purchase) of securities, net 89,649 26,942
Securities sold short -- (21,087)
Due from broker -- 21,087
Acquisition of intangibles -- (285)
Acquisition of ADS Holdings, Inc. -- (26,707)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 84,978 (8,419)
- --------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of margin account indebtedness (49,621) --
Proceeds from margin account indebtedness -- 107,323
Acquisition of convertible debt (72,304) (57,320)
Proceeds from exercise of options and warrants 24,990 13,238
AOL investment 55,000 --
Retirement of common stock -- (1,470)
Acquisition of treasury stock (7,686) (224,111)
- --------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (49,621) (162,340)
- --------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 40,489 (293,531)
Cash and cash equivalents, at beginning of period 3,063 316,730
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of period $ 43,552 $ 23,199
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basic Presentation
The consolidated financial statements include the accounts of Talk.com Inc.
and its wholly-owned subsidiaries, and have been prepared as if the entities had
operated as a single consolidated group since their respective dates of
incorporation. All intercompany balances and transactions have been eliminated.
The consolidated financial statements and related notes thereto as of
September 30, 1999 and for the three and nine months ended September 30, 1999
and 1998 are presented as unaudited but in the opinion of management include all
adjustments necessary to present fairly the information set forth therein. These
adjustments consist solely of normal recurring accruals. The consolidated
balance sheet information for December 31, 1998 was derived from the audited
financial statements included in the Company's Form 10-K, as amended. These
interim financial statements should be read in conjunction with that Form 10-K
report. The interim results are not necessarily indicative of the results for
any future periods.
2. AOL Agreements
The Company has negotiated a number of amendments to its marketing
agreements with America Online Inc. ("AOL") based on the experience gained by
the Company in the marketing and sale of telecom services to AOL subscribers
during 1998. A substantial amendment to the AOL agreement in January 1999 in
which the Company agreed to fixed quarterly payments ranging from $10 to $15
million during the exclusivity period of the agreement resulted in: the
elimination of the Company's obligation to make bounty and profit-sharing
payments to AOL; alteration of the terms of the online and offline marketing
arrangements between the Company and AOL; elimination of AOL's rights to receive
further common stock warrants based upon customers gained from the AOL
subscriber base; AOL's contribution of up to $4.0 million per quarter for
offline marketing; establishment of the framework for the Company to offer
additional services and products to AOL subscribers; and extension of the term
of the AOL agreement, including the long distance exclusivity period, until June
2003, although AOL can end the Company's long distance exclusivity period on or
after June 30, 2000 by foregoing the fixed quarterly payments described above.
The fixed payments to AOL are being amortized based on estimated benefits from
the AOL subscriber base.
On January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL purchased a total of 4,121,372 shares of common stock of the
Company for $55.0 million in cash and the surrender of rights to purchase
5,076,016 shares of common stock of the Company pursuant to various warrants
held by AOL. AOL agreed to end further vesting under the outstanding performance
warrant and retained vested warrants exercisable for 2,721,984 shares of Company
common stock. See Note 4(a) for a discussion of certain reimbursement
obligations of the Company in favor of AOL.
3. Related Party Transactions
On January 5, 1999, Mr. Daniel Borislow, a founder of the Company and its
Chairman of the Board and Chief Executive Officer, resigned as a director and
officer of the Company. The Company entered into various agreements and engaged
in various transactions with Mr. Borislow and certain entities in which he or
his family had an interest.
The Company paid $1.0 million to Mr. Borislow, assigned certain automobiles
to him, and continued certain of his health and medical benefits and director
and officer insurance. The Company also agreed that, as long as Mr. Borislow
owned beneficially and of record at least two percent (2%) of the common stock
(on a fully diluted basis), Mr. Borislow and trusts for the benefit of his
children would be entitled to: registration rights with respect to their shares
of common stock; the right to require the Company to use a portion of the
proceeds from any public or private sale of debt securities by the Company
(excluding borrowings from commercial banks or other financial institutions) to
repurchase debt securities of the Company owned by Mr. Borislow or the trusts
for the benefit of his children; and the right to require the Company to use the
proceeds from the exercise of stock options or share purchase rights to
repurchase common stock owned by Mr. Borislow or the trusts for the benefit of
his children (see Note 4 (b)). The Company also agreed that, as long as Mr.
Borislow had such beneficial and record ownership,
7
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the Company would not, without the prior written consent of Mr. Borislow and
subject to certain exceptions: (a) engage in certain significant corporate
transactions, including the sale or encumbrance of substantially all of its
assets, mergers and consolidations and certain material acquisitions, or, (b)
for a period of 18 months from the agreement date, offer or sell any of its
capital stock unless and until Mr. Borislow and the trusts have sold or
otherwise disposed of all the shares of common stock held by them on the
agreement date. In turn, Mr. Borislow terminated his employment with the Company
and agreed not to compete with the Company for at least one year. Mr. Borislow
also agreed to guarantee up to $20.0 million of the Company's obligations in
connection with the AOL investment discussed below.
On January 5, 1999, the Company assigned to a trust for the benefit of Mr.
Borislow's children the Company's interest in $53,700,000 principal amount of
subordinated notes of Communication TeleSystems International d/b/a WorldxChange
Communications, which were included in other assets at December 31, 1998, in
exchange for $62,545,000 aggregate principal amount of the Company's 2002
Convertible Notes and 2004 Convertible Notes owned by the trust. The exchange
rate was determined based on the Company's assessment of the fair values of the
WorldxChange Notes and of the Company's Convertible Notes given in exchange,
which assessment was supported by the opinion of an independent investment
banking firm as to the fairness to the Company of the consideration received.
On January 5, 1999, the Company, in open market transactions, purchased
from two trusts for the benefit of Mr. Borislow's children $65,080,000 aggregate
principal amount of the Company's 2002 Convertible Notes and 2004 Convertible
Notes owned by the trusts for $55.4 million in cash.
On March 18, 1999, the Company purchased from Mr. Borislow $11,477,000
aggregate principal amount of the Company's 2004 Convertible Notes for $10.0
million in cash with proceeds from the exercise of stock options pursuant to the
agreements with Mr. Borislow as described above. During the three month period
ended June 30, 1999, the Company purchased from Mr. Borislow approximately
639,000 shares of common stock for approximately $7.7 million with proceeds from
the exercise of stock options pursuant to the agreements with Mr. Borislow as
described above. On September 30, 1999, the Company purchased from Mr. Borislow
$9,300,000 aggregate principal amount of the Company's 2004 Convertible Notes
for $6.9 million in cash with the proceeds from the exercise of stock options
pursuant to agreements with Mr. Borislow.
4. Stockholders' Equity
(a) Contingent Redemption Value of Common Stock
On January 5, 1999, pursuant to an Investment Agreement between AOL and the
Company, AOL acquired 4,121,372 shares of common stock for $55.0 million in cash
and the surrender of rights to acquire up to 5,076,016 shares of common stock
pursuant to various warrants held by AOL. Under the terms of the Investment
Agreement with AOL, the Company has agreed to reimburse AOL for losses AOL may
incur on the sale of any of the 4,121,372 shares during the period from June 1,
1999 through September 30, 2000. The Company has the first right to purchase any
of the 4,121,372 shares of common stock at the market value on the day that AOL
notifies the Company of its intent to sell any of the shares plus an amount, if
any, equal to the Company's reimbursement obligation described below. The
reimbursement amount would be determined by multiplying the number of shares, if
any, that AOL sells during the applicable period by the difference between the
purchase price per share paid by AOL, or $19 per share, and the price per share
that AOL sells the shares for, if less than $19 per share. The reimbursement
amount may not exceed $14 per share for 2,894,737 shares or $11 per share for
1,226,635 shares. Accordingly, the maximum amount payable to AOL as
reimbursement on the sale of AOL's shares would be approximately $54.0 million
plus AOL's reasonable expenses incurred in connection with the sale. The Company
has the option of issuing a six-month 10% note payable to AOL to satisfy the
reimbursement amount or other amounts payable on exercise of its first refusal
rights. Assuming AOL were to sell all of its shares subject to the Company's
reimbursement obligation at the closing price of the Company's common stock as
of September 30, 1999, the reimbursement amount would be approximately $25.1
million. At September 30, 1999, the Company recorded $25.1 million for the
contingent redemption value of this common stock with a corresponding reduction
in additional paid-in capital. As previously reported, the Company received a
letter from AOL, dated August 25, 1999, stating that AOL did not intend to
exercise its reimbursement rights under the Investment Agreement (to require the
Company to reimburse AOL shortfalls on sales of the Company common stock that it
acquired in January 1999) any earlier than December 31, 1999. AOL also has the
right on termination of long distance
8
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
exclusivity under the AOL marketing agreements to require the Company to
repurchase the warrants to purchase 2,721,984 shares of common stock of the
Company held by AOL for a minimum price of $36.3 million, which repurchase price
can be paid in Company common stock, cash or a six-month note. AOL can end the
Company's long distance exclusivity period on or after June 30, 2000 by
foregoing certain fixed quarterly payments. The Company has pledged the stock of
its subsidiaries and has agreed to fund an escrow account of up to $35 million
from 50% of the proceeds of any debt financing, other than a bank, receivable or
other asset based financing of up to $50 million, to secure its obligations
under the Investment Agreement with AOL. AOL has agreed that it will subordinate
its security interests to permit the securitization of certain future financings
by the Company. Mr. Borislow has agreed to guarantee up to $20,000,000 of the
Company's reimbursement obligations under the Investment Agreement with AOL.
(b) Restriction on Future Sales of Common Stock
As previously reported, the Company was subject to certain restrictions
under a registration rights agreement between the Company and Mr. Borislow that
could have affected the Company's ability to raise capital and engage in other
types of financing transactions. Since Mr. Borislow currently holds less than 2%
of the Company's outstanding common stock, these restrictions have been
suspended and no longer apply to the Company. If at a later date Mr. Borislow's
beneficial and record ownership of common stock equals or exceeds 2% solely as a
result of Mr. Borislow receiving distributions of common stock from two existing
trusts organized for the benefit of his children, then such restrictions would
once again apply to the Company. In all events, under the terms of the
registration rights agreement with Mr. Borislow, these restrictions, even if
they should become applicable again to the Company, shall expire on June 30,
2000 and be of no further force and effect, regardless of the ownership by Mr.
Borislow of shares of common stock.
5. Legal Proceedings
On June 16, 1998, a purported shareholder class action was filed in the
United States District Court for the Eastern District of Pennsylvania against
the Company and certain of its officers alleging violation of the securities
laws in connection with certain disclosures made by the Company in its public
filings and seeking unspecified damages. Thereafter, additional lawsuits making
substantially the same allegations were filed by other plaintiffs in the same
court. At this point, no classes have been certified. A motion to dismiss was
granted as to certain officers of the Company and denied as to the Company.
There are currently no officers of the Company who are parties to these actions.
The Company believes the allegations in the complaints are without merit and
intends to defend the litigations vigorously. The Company also is a party to
certain legal actions arising in the ordinary course of business.
The Company believes that the ultimate outcome of the foregoing actions
will not result in liability that would have a material adverse effect on the
Company's financial condition of results of operations.
9
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following tables set forth for the periods indicated certain
financial data as a percentage of sales:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1999 1998
---- ----
<S> <C> <C>
Sales 100.0% 100.0%
Cost of sales 61.0 81.4
----- -----
Gross profit 39.0 18.6
General and administrative expenses 8.1 8.8
Promotional, marketing and advertising expenses 19.8 87.9
Significant other charges -- 0.3
----- -----
Operating income (loss) 11.1 (78.4)
Investment and other income (expense), net (0.6) 3.1
----- -----
Income (loss) before income taxes 10.5 (75.3)
Provision for income taxes -- --
----- -----
Income (loss) before extraordinary gain 10.5 (75.3)
Extraordinary gain 1.6 41.2
----- -----
Net income (loss) 12.1% (34.1)%
===== =====
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1999 1998
---- ----
Sales 100.0% 100.0%
Cost of sales 63.5 83.0
----- -----
Gross profit 36.5 17.0
General and administrative expenses 8.3 9.4
Promotional, marketing and advertising expenses 17.3 59.3
Significant other charges (income) (0.8) 6.7
----- -----
Operating income (loss) 11.7 (58.4)
Investment and other income (expense), net (0.5) --
----- -----
Income (loss) before income taxes 11.2 (58.4)
Provision for income taxes -- 12.5
----- -----
Income (loss) before extraordinary gain 11.2 (70.9)
Extraordinary gain 5.7 15.6
----- -----
Net income (loss) 16.9% (55.3)%
===== =====
</TABLE>
10
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS
ENDED SEPTEMBER 30, 1998
Sales. Sales increased by 14.3% to $140.0 million in the third quarter
of 1999 from $122.5 million in the third quarter of 1998. The increase in sales
primarily reflected an increase in the number of online customers. The increase
in online sales was partially offset by a decrease in the Company's other sales.
Cost of Sales. Cost of sales decreased by 14.3% to $85.5 million in the
third quarter of 1999 from $99.8 million in the third quarter of 1998. This
decrease was primarily due to lower network usage costs for services on the
Company's OBN network on a per minute basis and lower partition costs due to the
decrease in other sales, as noted above.
Gross Margin. Gross margin increased to 39.0% in the third quarter of
1999 from 18.6% in the third quarter of 1998. The increase in gross margin was
primarily due to lower network usage costs for OBN services on a per minute
basis and lower partition costs due to the decrease in other sales, as noted
above. The Company anticipates continued gross margin improvement; however,
price competition continues to intensify for the Company's products and this
trend can be expected to continue to put downward pressure on gross margins.
Other Operating Expenses. General and administrative expenses increased
by 4.2% to $11.3 million in the third quarter of 1999 from $10.8 million in the
third quarter of 1998. The increase in general and administrative expenses was
due primarily to increased costs associated with hiring additional personnel to
support the Company's continuing growth, offset by the elimination of general
and administrative expenses of TSFL Holdings, Inc. (as discussed below) and
decreased fees for professional services. During the third quarter of 1999, the
Company incurred $27.7 million of promotional, marketing and advertising expense
to expand its online customer base. During the third quarter of 1998, the
Company incurred $107.7 million of promotional, marketing and advertising
expense, including $16.3 million related to the AOL Agreement, $5.9 million for
the performance warrants issued to AOL on September 30, 1998 and $85.5 million
of promotional, marketing and advertising expense to expand its online customer
base.
Investment and Other Income (Expense), Net. Investment and other income
(expense), net was $(0.9) million in the third quarter of 1999 versus $3.8
million in the third quarter of 1998. During the third quarter of 1999,
investment and other income (expense), net consists primarily of interest income
offset by interest expense related to the Company's convertible debt.
Extraordinary gain. During the third quarter of 1999, the Company
recorded an extraordinary gain of $2.2 million from the acquisition of the
Company's convertible debt at a discount from its aggregate principal amount.
11
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS
ENDED SEPTEMBER 30, 1998
Sales. Sales increased by 13.2% to $367.7 million in the first nine
months of 1999 from $324.8 million in the first nine months of 1998. The
increase in sales primarily reflected an increase in the number of online
customers. The increase in online sales was partially offset by a decrease in
the Company's other sales.
Cost of Sales. Cost of sales decreased by 13.3% to $233.6 million in
the first nine months of 1999 from $269.4 million in the first nine months of
1998. This decrease was primarily due to lower network usage costs for services
on the Company's OBN network on a per minute basis and lower partition costs due
to the decrease in other sales, as noted above.
Gross Margin. Gross margin increased to 36.5% in the first nine months
of 1999 from 17.0% in the first nine months of 1998. The increase in gross
margin was primarily due to lower network usage costs for OBN services on a per
minute basis and lower partition costs due to the decrease in other sales, as
noted above.
Other Operating Expenses. General and administrative expenses decreased
by 0.6% to $30.5 million in the first nine months of 1999 from $30.6 million in
the first nine months of 1998. The decrease in general and administrative
expenses was due primarily to the elimination of general and administrative
expenses of TSFL Holdings, Inc. (as discussed below) and decreased fees for
professional services, offset by increased costs associated with hiring
additional personnel to support the Company's continuing growth. During the
first nine months of 1999, the Company incurred $63.5 million of promotional,
marketing and advertising expense to expand its online customer base. During the
first nine months of 1998, the Company incurred $192.6 million of promotional,
marketing and advertising expense, including $49.7 million related to the AOL
Agreement, $22.0 million for the performance warrants issued to AOL during the
first nine months of 1998 and $120.9 million of promotional, marketing and
advertising expense to expand its online customer base. During the first nine
months of 1999, the Company sold TSFL Holdings, Inc. (formerly Symetrics
Industries, Inc.), resulting in a gain of $2.7 million which was included in
significant other charges (income). During the first nine months of 1998, the
Company allocated $21.0 million of the acquisition cost of TSFL Holdings, Inc.
to purchased research and development expense, which was included in significant
other charges (income).
Investment and Other Income (Expense), Net. Investment and other income
(expense), net was $(1.9) million in the first nine months of 1999 versus
$(59,000) in the first nine months of 1998. During the first nine months of
1999, investment and other income (expense), net consists primarily of interest
income offset by interest expense related to the Company's convertible debt.
Extraordinary gain. During the first nine months of 1999, the Company
recorded an extraordinary gain of $21.2 million from the acquisition of the
Company's convertible debt at a discount from its aggregate principal amount.
12
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was $50.5 million and $13.1 million at
September 30, 1999 and December 31, 1998, respectively. This increase in working
capital is primarily a result of the cash generated during the first nine months
1999 from the Company's operations.
The Company expended an aggregate of $132.9 million of cash, Company
common stock and other consideration for the repurchase of an aggregate
principal amount of $157.4 million of Convertible Notes during the first nine
months of 1999. The Company (a) purchased from Mr. Borislow and two trusts for
the benefit of Mr. Borislow's children $85,857,000 aggregate principal amount of
the Company's Convertible Notes for $72.3 million in cash; (b) exchanged the
$53.7 million remaining on the WorldxChange Notes to a trust for the benefit of
Mr. Borislow's children for $62,545,000 aggregate principal amount of the
Company's Convertible Notes and (c) purchased $9,000,000 aggregate principal
amount of the Company's Convertible Notes for $6.9 million in Company common
stock. As of September 30, 1999, the Company had reduced the principal amount
outstanding of its Convertible Notes to $85.0 million ($66.9 million of 4 1/2%
notes and $18.1 million of 5% notes). The Company also purchased from Mr.
Borislow approximately 639,000 shares of common stock for approximately $7.7
million during the first six months of 1999 with proceeds from the exercise of
stock options pursuant to agreements with Mr. Borislow.
On January 5, 1999, pursuant to an Investment Agreement between AOL and
the Company, AOL acquired 4,121,372 shares of common stock for $55.0 million in
cash and the surrender of rights to acquire up to 5,076,016 shares of common
stock pursuant to various warrants held by AOL. Under the terms of the
Investment Agreement with AOL, the Company has agreed to reimburse AOL for
losses AOL may incur on the sale of any of the 4,121,372 shares during the
period from June 1, 1999 through September 30, 2000. The Company has the first
right to purchase any of the 4,121,372 shares of common stock at the market
value on the day that AOL notifies the Company of its intent to sell any of the
shares plus an amount, if any, equal to the Company's reimbursement obligation
described below. The reimbursement amount would be determined by multiplying the
number of shares, if any, that AOL sells during the applicable period by the
difference between the purchase price per share paid by AOL, or $19 per share,
and the price per share that AOL sells the shares for, if less than $19 per
share. The reimbursement amount may not exceed $14 per share for 2,894,737
shares or $11 per share for 1,226,635 shares. Accordingly, the maximum amount
payable to AOL as reimbursement on the sale of AOL's shares would be
approximately $54.0 million plus AOL's reasonable expenses incurred in
connection with the sale. The Company has the option of issuing a six-month 10%
note payable to AOL to satisfy the reimbursement amount or other amounts payable
on exercise of its first refusal rights. Assuming AOL were to sell all of its
shares subject to the Company's reimbursement obligation at the closing price of
the Company's common stock as of September 30, 1999, the reimbursement amount
would be approximately $25.1 million. At September 30, 1999, the Company
recorded $25.1 million for the contingent redemption value of this common stock
with a corresponding reduction in additional paid-in capital. As previously
reported, the Company received a letter from AOL, dated August 25, 1999, stating
that AOL did not intend to exercise its reimbursement rights under the
Investment Agreement (to require the Company to reimburse AOL shortfalls on
sales of the Company common stock that it acquired in January 1999) any earlier
than December 31, 1999. AOL also has the right on termination of long distance
exclusivity under the AOL marketing agreements to require the Company to
repurchase the warrants to purchase 2,721,984 shares of common stock of the
Company held by AOL for a minimum price of $36.3 million, which repurchase price
can be paid in Company common stock, cash or a six-month note. AOL can end the
Company's long distance exclusivity period on or after June 30, 2000 by
foregoing certain fixed quarterly payments. The Company has pledged the stock of
its subsidiaries and has agreed to fund an escrow account of up to $35 million
from 50% of the proceeds of any debt financing, other than a bank, receivable or
other asset based financing of up to $50 million, to secure its obligations
under the Investment Agreement with AOL. AOL has agreed that it will subordinate
its security interests to permit the securitization of certain future financings
by the Company. Mr. Borislow has agreed to guarantee up to $20,000,000 of the
Company's reimbursement obligations under the Investment Agreement with AOL.
As previously reported, the Company was subject to certain restrictions
under a registration rights agreement between the Company and Mr. Borislow that
could have affected the Company's ability to raise capital and engage in other
types of financing transactions. Since Mr. Borislow currently holds less than 2%
of the
13
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
Company's outstanding common stock, these restrictions have been suspended and
no longer apply to the Company. If at a later date Mr. Borislow's beneficial and
record ownership of common stock equals or exceeds 2% solely as a result of Mr.
Borislow receiving distributions of common stock from two existing trusts
organized for the benefit of his children, then such restrictions would once
again apply to the Company. In all events, under the terms of the registration
rights agreement with Mr. Borislow, these restrictions, even if they should
become applicable again to the Company, shall expire on June 30, 2000 and be of
no further force and effect, regardless of the ownership by Mr. Borislow of
shares of common stock.
The Company generally does not have a significant concentration of
credit risk with respect to accounts receivable due to the large number of end
users comprising the Company's customer base and their dispersion across
different geographic regions. The Company maintains reserves for potential
credit losses and, to date, such losses have been within the Company's
expectations.
The Company does not, and has not historically, required significant
amounts of working capital for its day-to-day operations. The Company believes
that its current cash position and the cash flow expected to be generated from
operations will be sufficient to fund its capital expenditures, working capital
and other cash requirements for at least the next twelve months. The Company
also believes that, assuming the current market price of its common stock, its
cash flow from operations will be sufficient to fund any reimbursement amount in
the event that AOL elects to sell its shares of the Company's common stock at a
price below $19 per share and that, alternatively, it has the ability to obtain
the necessary financing to fund its obligations under the AOL Investment
Agreement. Should the Company seek to raise additional capital, there can be no
assurance that, given current market conditions, the Company would be able to
raise such additional capital on terms acceptable to the Company.
YEAR 2000
The "Year 2000 issue" refers to the potential harm from computer
programs that identify dates by the last two digits of the year rather than
using the full four digits. Such programs could fail due to misidentification of
dates on or after January 1, 2000. If such a failure were to occur to the
Company's internal computer-based systems or to the computer-based systems
operated by third parties that are critical to the Company's operations, the
Company could be unable to continue to provide telecommunications services, to
sign up new customers or to bill existing customers for services. Such failures,
if they occurred, would have a material adverse effect on the Company's
business, results of operations and financial condition. However, because of the
complexity of the issues, the number of parties involved and the fact that many
of the issues are outside the Company's control, the Company cannot reasonably
predict with certainty the nature or likelihood of such effects.
The Company, using its internal staff, has conducted a review and test
of most of the internal computer-based systems. Most of the Company's systems
are relatively new. Much of the software used by the Company has been developed
internally and is regularly modified and updated to meet the changing
requirements of its business. The Company expects that its critical internal
systems will be able to process relevant date information in the future to
permit the Company to continue to provide its services without significant
interruption or material adverse effect on its business, results of operations
and financial condition. However, there can be no assurances that the Company
will not experience unanticipated negative consequences caused by undetected
errors or defects in the technology used in its internal systems.
Notwithstanding the Company's expectation that its own systems will be able
to process Year 2000 date information, the Company's business depends
significantly on receiving uninterrupted services by other parties. The
principal service suppliers to the Company include other switch-based
long-distance providers, the local exchange carriers throughout the country and
AOL. Other parties whose ability to deal with Year 2000 issues could affect the
Company include the Company's partitions and the credit and debit card companies
through which most of the Company's online customers are billed. The Company has
made inquiry of some of these parties regarding their respective levels of
preparedness for Year 2000 issues as they may affect the Company. The Company
will continue to make such inquiries and will monitor the public disclosures of
such companies regarding their Year 2000 status. So far, the responses to such
inquiries have been generally non-committal regarding levels of preparedness or
willingness to provide assurances to the Company. In almost all cases, the
Company is not in a position to require either affirmative action or assurances
by these parties regarding continued provision of services in the Year 2000.
Accordingly, while the Company has not been advised by any of these other
companies on which it depends that they do not expect to be ready for Year 2000
issues, the Company does not believe it is in a position to project the
likelihood of such parties' abilities to provide uninterrupted services to the
Company. The Company has considered 14
<PAGE>
TALK.COM INC. AND SUBSIDIARIES
possible contingency plans. Although the Company has entered into multiple
contracts with long-distance service providers to support its OBN network, the
failure of any of the significant suppliers to provide uninterrupted service to
the Company would likely have a material adverse effect on the Company's
business and its results of operations and financial condition.
The Company does not separately identify costs incurred in connection
with Year 2000 compliance activities. To date, however, the Company does not
believe such costs to be significant because they generally have been incurred
in the normal course of internally modifying and updating the Company's software
programs. Future expenditures are not expected to be significant and will be
funded out of operating cash flows.
* * * * *
Certain of the statements contained herein may be considered
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements are identified by the use of forward-looking words or phrases,
including, but not limited to, "estimates," "expects," "expected,"
"anticipates," and "anticipated." These forward-looking statements are based on
the Company's current expectations. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, there
can be no assurance that such expectations will prove to have been correct.
Forward-looking statements involve risks and uncertainties and the Company's
actual results could differ materially from the Company's expectations. In
addition to those factors discussed elsewhere herein, important factors that
could cause such actual results to differ materially include, among others,
adverse developments in the Company's relationship with AOL, increased price
competition for long distance services, failure of the marketing of long
distance services under the AOL Agreement and its other marketing agreements,
attrition in the number of end users, and changes in government policy,
regulation and enforcement. The Company undertakes no obligations to update its
forward-looking statements.
15
<PAGE>
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company's Annual Meeting of Stockholders was held on
November 10, 1999 ("Annual Meeting").
(b) Not applicable.
(c) At the Annual Meeting, the stockholders of the Company
considered and approved the following proposals:
(i) Election of Director. The following sets forth the nominee
who was elected a director of the Company for the term
expiring in the year indicated as well as the number of
votes cast for, against or withheld.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
VOTES
TERM (YEAR EXPIRES) NAME FOR AGAINST WITHHELD
2002 Mark S. Fowler 45,389,023 0 6,032,671
</TABLE>
(ii) At the Annual Meeting the stockholders approved the
appointment of BDO Seidman LLP as independent certified
public accountants of the Company. The appointment
received 51,299,558 votes in favor, 75,265 votes in
opposition and 46,871 votes abstained from such.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Computation of Net Income Per Share
27 Financial Data Schedule
(b) Reports on Form 8-K
Since June 30, 1999, the Company filed one Current Report
on Form 8-K, which related to the Company's adoption of a
shareholder rights plan and disclosed that the Company had
received a letter from America Online, Inc. relating to its
intent with respect to the Investment Agreement, as previously
described in this Report.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 1999 TALK.COM INC.
--------------------------------
(Registrant)
By: /s/ Gabriel Battista
--------------------------------
Gabriel Battista
Chief Executive Officer
By: /s/ Edward B. Meyercord, III
--------------------------------
Edward B. Meyercord, III
Chief Financial Officer
By: /s/ Kevin R. Kelly
--------------------------------
Kevin R. Kelly
Controller
17
EXHIBIT 11
TALK.COM INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------- --------------------------------
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income (loss) before extraordinary gain $ 14,646 $ (92,296) $ 41,018 $ (230,245)
Extraordinary gain 2,233 50,562 21,230 50,562
--------- --------- -------- -----------
Net income (loss) $ 16,879 $ (41,734) $ 62,248 $ (179,683)
========= ========= ======== ===========
BASIC
Weighted average common shares outstanding - Basic: 61,343 58,376 60,233 62,317
========= ========= ======== ===========
Income (loss) before extraordinary gain $ 0.24 $ (1.58) $ 0.68 $ (3.69)
Extraordinary gain 0.04 0.87 0.35 0.81
--------- --------- -------- -----------
Net income (loss) $ 0.28 $ (0.71) $ 1.03 $ (2.88)
========= ========= ======== ===========
DILUTED
Weighted average common and common equivalent
shares outstanding - Diluted:
Weighted average shares 61,343 58,376 60,233 62,317
Effect of assumed conversion of common stock options 2,137 -- 2,860 --
--------- --------- -------- -----------
Weighted average common and common equivalent shares -
Diluted 63,480 58,376 63,093 62,317
========= ========= ======== ===========
Income (loss) before extraordinary gain $ 0.23 $ (1.58) $ 0.65 $ (3.69)
Extraordinary gain 0.04 0.87 0.34 0.81
--------- --------- -------- -----------
Net income (loss) $ 0.27 $ (0.71) $ 0.99 $ (2.88)
======== ========= ======== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1999 AND THE
UNAUDITED CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1999 OF TALK.COM INC. AND SUBSIDIARIES AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 000948545
<NAME> TALK.COM INC.
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 43,552,000
<SECURITIES> 0
<RECEIVABLES> 61,028,000
<ALLOWANCES> 3,729,000
<INVENTORY> 0
<CURRENT-ASSETS> 113,345,000
<PP&E> 68,938,000
<DEPRECIATION> 11,951,000
<TOTAL-ASSETS> 175,264,000
<CURRENT-LIABILITIES> 62,804,000
<BONDS> 84,985,000
0
0
<COMMON> 669,000
<OTHER-SE> (21,159,000)
<TOTAL-LIABILITY-AND-EQUITY> 175,264,000
<SALES> 0
<TOTAL-REVENUES> 367,738,000
<CGS> 0
<TOTAL-COSTS> 233,592,000
<OTHER-EXPENSES> 91,233,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,187,000
<INCOME-PRETAX> 41,018,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 41,018,000
<DISCONTINUED> 0
<EXTRAORDINARY> 21,230,000
<CHANGES> 0
<NET-INCOME> 62,248,000
<EPS-BASIC> 1.03
<EPS-DILUTED> 0.99
</TABLE>
